Permission is granted for John E. Mayer to post the following issue
of Charitable Gift Planning News on his website.

Charitable Gift Planning News

September 2000

Vol. 18/No. 9

CASES
IN THE NEWS

CRT That Fails to Make Distributions is Not a CRT

Estate of Melvine B. Atkinson
v. Commissioner, 115 T.C. No. 3 (July 26, 2000), answers a question that haunts many a gift planner.
What if a charitable remainder trust is drafted correctly, contains all the
necessary language and none of the forbidden provisions, but in practice the
trust is not administered in accordance with its governing instrument? The
answer may not be unexpected, but it is harsh – the trust is not a qualified
CRT and the charitable deduction otherwise allowable will be denied.

The facts were complicated, but in
essence here is what happened. Melvine B. Atkinson of Miami Beach, Florida, created a charitable remainder annuity trust in 1991
and placed stock worth just under $4 million in the trust. The terms of the
trust called for payment of a five percent annuity to her, in quarterly
installments of $49,999.68, but no such payments were ever made. The court
stated that the trustee, one Christopher J. MacQuarrie, was aware of the
required payments and of the fact that Atkinson “was not withdrawing money from
the trust.”

She died in 1993, at the age of
97, and the trust called for further lifetime distributions to other
individuals, but only if they agreed to pay the State and Federal death taxes
due on their interests in the trust. Mary Birchfield was the only one of these
secondary life beneficiaries who elected to take her share, but she claimed
that Atkinson had promised that she would not have to pay the taxes on her
share. After “increasingly hostile exchanges,” the estate settled the claim and
got a probate court order permitting the taxes on Birchfield’s share to be paid
out of the estate, but the assets were insufficient so the CRT will have to be
invaded to make up the shortfall.

When Atkinson died, the trust was
included in her estate for Federal estate tax purposes. Her estate would be
entitled to an estate tax charitable deduction for the charitable remainder
interest, but only if the trust was a qualified charitable remainder trust
under Code. Sec. 664.On these facts,
the Tax Court held that the trust was NOT qualified, so no charitable deduction
was allowed. Although the trust instrument properly provided for distributions
to the life beneficiaries, in practice the trust did not operate in accordance
with the terms of the governing instrument. The estate bore the burden of proof
on this issue and it was unable to establish that checks were prepared and sent
to the decedent. The trust was never diminished by any payments during her
lifetime. For this reason it failed to meet the 5-percent minimum distribution
requirement and was not a qualified trust.

The court also noted another
point. While reformation is available for many nonqualifying charitable
remainder trusts, that remedy is applicable only where the trust is
disqualified by problems in the trust documentation. The Atkinson trust was
validly drafted and thus did not need a re-formation to rewrite incorrect
terms.Its problems were operational and
a failure of that sort cannot be corrected by reformation.

This case could be the most
important CRT development of the year. Planners routinely encounter charitable
remainder trusts that have failed in one way or another to follow the
applicable rules or the terms of the trust instrument. Indeed, the Internal
Revenue Service is often receptive to a reasonable attempt to correct the
situation and go forward with a plan that saves the trust from
disqualification. Here, the parties never did attempt to rectify the trust’s
failure to make distributions. Would the result be different if they had? This
answer must await future developments.

Another point worth noting is
that even if this trust had made distributions as required, it could have been
disqualified on another ground – the necessity to invade the trust corpus to
pay estate taxes on Birchfield’s share. The IRS raised this point, but the Tax
Court never had to reach it.

Drafting 101: Identifying the
Beneficiary

McDonald & Company
Securities, Inc., Gradison Division v. Alzheimer’s Disease and Related
Disorders Association, Inc. et al., 2000 Ohio App. LEXIS 3248, Court of Appeals of Ohio
(1st App. Distr., Hamilton County). Fred Weisman died and maned as a
beneficiary of his individual retirement account(“IRA”) the “Alzheimer’s ResearchCenter.”The
securities firm administering his IRA was unable to determine with certainty
the Fred intended any one organization to take this gift, and brought this suit
for a declaratory judgment to resolve the situation.

Three organizations claimed the gift: the
University of Cincinnati College of Medicine Alzheimer’s ResearchCenter (“the University”), Alzheimer’s Disease and related
Disorders Assn., Inc., commonly known as the Alzheimer’s Association (“AA”) and
American Health Assistance Foundation (“AHAF”). During his lifetime, Fred had
given small contributions to two of these organizations: a $20 check, payable
to “Alzheimer’s Disease Association ”to AA; plus a $15 check payable to
“Alzheimer’s Research,” and a $25 check payable to “Alzheimer’s Disease
Research” to AHAF. AHAF sponsors a program called “Alzheimer’s Disease
Research. The University was a local institution bearing the same name Fred had
put in his IRA beneficiary designation, but he had no apparent connection with
it during his lifetime.

The appellate court upheld the
probate court’s holding that the intended beneficiary could not be determined
with certainty, and that Fred had indicated a general charitable intention to
help patients with Alzheimer’s Disease. Accordingly, the contested funds were
divided equally among the three claimants. The real lesson for planners is in
the concurring opinion of Judge Painter:

“The public should realize the danger in attempting to
have a substantial portion of their wealth pass to their heirs or beneficiaries
by IRA accounts, brokerage accounts, insurance policies, bank-deposit accounts,
and the like. Often, as here, these documents are not prepared by a lawyer, not
subject to the legal formalities of a will, and not artfully completed. For
someone with the substantial assets involved here, an estate plan would have
been advisable, so an attorney could have reviewed all documents such as this,
avoiding ambiguity and its attendant costs, and ensuring that the decedent’s
wishes were followed.”

Calendar Notation Not Sufficient to Prove Charitable
Contributions

Daniela Aldea v. Commissioner, TC Memo 2000-136 (4/12/2000). Daniela Aldea was a regular churchgoer and in 1995
she gave cash contributions totaling $1,160 to two churches. When the IRS
challenged her deductions for lack of proof, she took her claim to the Tax
Court. She testified to the court that she had made these contributions and
offered two forms of proof – handwritten letters from two individuals stating
that she had attended their churches regularly and a 1995 calendar with the notation
“church” and a dollar amount (usually $20) on each Sunday.

Sorry, said the court, this evidence is not
enough.The judge wasn’t convinced that
the calendar notations were made contemporaneously in 1995, and the letters
didn’t identify any particular church nor indicate that Daniela made any
contributions.

Although neither a groundbreaking case nor a
surprising result, this decision does remind us that even small contributions must
be substantiated. The “contemporaneous written acknowledgment” rule is
inapplicable to gifts under $250, and the regulations treat contributions of
$20 per week like the ones in this case as a series of separate $20
contributions, without aggregating them. Nevertheless, there are still rules to
be followed. Here, the court noted, canceled checks, receipts, or “other
reliable written records” showing the donee, date and amount of the alleged
contributions could have saved the day. The judge seemed to doubt whether this
donor had actually made any contributions.

Life Tenant and Charity Allowed to Sell Property and
Divide the Proceeds

In re Estate of Kenneth C. Hewitt. 554 Pa. 486, 721 A. 2d 1082, (12/22/98). When Kenneth Hewitt died, he left Helen Colwell a
life estate in his condominium apartment, provided she notified the executor
within 120 days of “her election to occupy” the apartment. At her death, the
apartment was to be sold and the proceeds distributed to a charitable remainder
trust created under Mr. Hewitt’s will. Mrs. Colwell sent her notice to the
executor in timely fashion.

Thereafter, Mrs. Colwell and the executor sold the
apartment and the proceeds were divided between her and the trust based on
their respective actuarial interests. The Pennsylvania Attorney General
objected, claiming that because Mrs. Colwell never occupied the apartment, she
was never became entitled to any interest in the property. Thus, in the view of
the AG, the entire proceeds should have passed to the CRT. The lower courts
agreed with the Attorney General, but the Pennsylvania Supreme Court said Mrs
Colwell could keep her share of the proceeds. She properly exercised her
election to take a life interest in the property and was entitled to keep it or
sell it. The remainderman (the CRT) owned the rest of the property, but its
interest was subject to her life estate. These two parties were free to join
together in a sale of the property and divide the proceeds according to their
respective interests.

This case may demonstrate a potential solution for
parties who find themselves in this situation. Often a life tenant is either
reluctant or unable to occupy the subject property, either at the outset or at
a later date. This may be the case when an elderly life tenant is no longer
able to live without assistance, and finds it necessary to move to an assisted
care facility. A person who gives to charity a remainder interest in a personal
residence or farm is entitled to a deduction for the actuarial value of the remainder,
but only if the remainder beneficiary receives an actual legal interest in the
residence or farm, and not the proceeds of its sale. The parties may be tempted
to include in the deed a provision requiring sale of the property and division
of the proceeds under some circumstances, but the IRS has ruled that this can
spoil the donor’s deduction. See Rev. Rul.76‑543 , 1976‑2 C.B. 387,
and Rev. Rul. 77-169, 1979-1 CB 286. As this case shows, the parties are free
to arrange a sale on their own without so providing in the governing document
(here, Mr. Hewitt’s will).

IRS IN THE NEWS

Gift Substantiation Via E-Mail? (Would That Be
Cybersubstantiation?)

IRS General Information Letter 2000-0070 – A taxpayer
wrote to the Internal Revenue Service to ask whether the substantiation
requirements of Code. Secs. 170(f)(8) and 6115 [regarding receipts for gifts
over $250 receipt rule and quid-pro-quo disclosure] would be met if the donee
supplied the necessary documentation to the donor in timely fashion via electronic
mail. The answer – a definite maybe. IRS noted that it had not previously ruled
on this issue, but said it would “probably” accept this form of substantiation.

The taxpayer’s second question was harder. May a
for-profit entity using the Internet to solicit charitable contributions for
nonprofits provide the required substantiation to donors? Ask us later, in a
private letter ruling request, said the IRS. This novel and complex question
was deemed to be beyond the scope of what can be answered in a general
information letter.

PRIVATE LETTER RULINGS OF INTEREST

CRT May Permit Corpus Distributions to Charitable
Remainderman

LR 200010035. A
and B created a private foundation in 1988, and in 1994 they created a
charitable remainder annuity trust for themselves with the remainder payable to
the foundation. Now it appears that the trust ‘s assets have nearly doubled in
value, while the foundation increasing costs have outpaced its revenues. To
help improve the financial condition of the foundation, A and B now propose to
reform the trust so as to permit distribution of corpus, plus any income in
excess of its annuity obligation, to the foundation.

The Internal Revenue Service approved the proposed
change, holding that the change would not affect either the status of the trust
as a qualified charitable remainder trust under Code Sec. 664 or the tax exempt
status of either the trust or the foundation. In addition, none of the parties
would incur adverse income tax, gift tax, self-dealing tax, or termination tax
(under Code Sec. 507) consequences as a result of these changes.

The IRS noted that the Regulations [in Sec.
1.664-2(a)(4)] specifically permit distributions to qualified charitable organizations.
This is a provision that gift planners might well bring to the attention of
donors when proposing or preparing a charitable remainder trust.The donor may very well wish to authorize
distributions to charity if this possibility is brought to his/her attention
when the trust is created.

In Case You Wondered . . . Grantor Can Be CRT Trustee

LR 200029031. Sometimes the results of a proposed transaction seem
so clear that one wonders why the taxpayers involved felt obliged to request a
private letter ruling. This is one of those rulings. A and B (no, not the same
A and B as in the ruling just described) created a charitable remainder
unitrust funded with publicly traded stock and named an institution as trustee.
Subsequently they removed the trustee and named themselves as cotrustees, and
(apparently at a later date) emended the trust instrument to prohibit
investments in assets which do not have an objectively ascertainable market
value and would result in disallowance of the charitable deduction.

Those changes, naming the grantors as cotrustees and
limiting trust investments to assets which have an objectively ascertainable
market value, do not disqualify the trust as a charitable remainder unitrust
under Code Sec. 664 and the applicable regulations, are OK with us said the
Internal Revenue Service.

This ruling reaches what would seem to be an obvious
result, although it was so heavily redacted as to make that less than clear.
After all, sometimes the reasons for seeking a ruling are hidden in such
details as the amount involved (described as $x here) or other details obscured
in the final ruling. One aspect of the ruling that was not by the IRS may be
interesting to gift planners who are absorbed by such things. [Other readers
may simply say, “Get a Life!”]

For those who are still reading, here’s something to
ponder. This trust included the usual provision stating that it was irrevocable
and could be amended “for the sole purpose of ensuring that the Trust qualifies
and continues to qualify as a charitable remainder unitrust.” And we are told
that A and B, as trustees, amended the trust to add the prohibition on
hard-to-value investments. Was that necessary to ensure that the trust
continues to be qualified? Stated differently, did the trustees have the power
to make that amendment. The recent amendment to the regulations provides that
such assets may raise problems for a unitrust unless the annual
valuation is (1) performed by an independent trustee, or (2) determined via a
current qualified appraisal. This ruling even cited and described this
regulation. So why would this amendment even be permitted under the instrument,
let alone be necessary to assure continued qualification?

Compare this apparent failure to follow the terms of
the trust instrument with the massive failure in the Atkinson case
discussed on page 1 of this issue. Obviously the facts in this ruling involve a
harmless departure from the trust instrument (if indeed this questionable
amendment is a departure at all)compared with the complete breakdown in Atkinson.
But this may be an interesting insight into how the IRS views such issues.

Perhaps the forthcoming revision of the Internal
Revenue Service sample CRT forms (reported in the last issue of CGP News) will
help clarify what is required, permitted, and forbidden in this area.

Bequest to Rebuild Foreign Mosque Is Deductible

LR 200024016.
The decedent (let’s call him D), a US citizen, provided a bequest in his will for the
rebuilding of a mosque in his home town in a foreign country under the
supervision of his nephew. The mosque was built by D’s great-grandfather in
1910, and is in such a deteriorated condition that it will have to be
demolished and rebuilt. With the approval of the probate court, D’s executor
created a charitable trust to receive this bequest. [Why? The parties
represented that this was done to comply with Louisiana law, to eliminate exposure to construction liability,
and to maximize the funds available.] The sole purpose of the trust is to
reconstruct the Mosque and thereby support its religious, educational, medical
and social purposes. The decedent’s nephew, an engineer in the country where
the Mosque is located, will serve as trustee of the trust. On the termination
of the trust, all its remaining assets (other than those relating to the
Mosque) will be distributed to a section 501(c)(3) organization supportive of
the Moslem religion. The IRS has recognized the exemption of the trust under
section 501(c)(3).

On this basis, the Internal Revenue Service held that
D’s estate will be entitled to an estate tax charitable deduction upon
distributing the bequest to the trust.

The
foreign nature of the Mosque project does not jeopardize the estate tax
charitable deduction, as demonstrated by a number of cases and rulings. Unlike
the income tax charitable deduction provision, which limits deductions to
domestic organizations, the estate tax charitable deduction is not so limited.
What is novel here is the manner in which D’s estate carried out the bequest in
support of this mosque reconstruction project. By forming a separate trust and
qualifying it as a section 501(c)(3) organization in its own right, the estate
was able to assure the deduction and carry out the literal terms of D’s bequest
for rebuilding the Mosque under the supervision of D’s nephew. Planners might
bear this approach in mind and consider a limited-life, special purpose
charitable organization for comparable situations.

READER’S GUIDE

Now it’s official! Topic A for periodicals in
recent weeks has been the new wave of philanthropic undertakings by young, dot
com entrepreneurs. The July 24, 2000, issue of Time Magazine featured a cover
emblazoned with “The New Philanthropists:They’re hands on. They want results. Who gives, and how much.” Inside,
the following stories appear:

“A New Way of Giving,” by Karl Taro Greenfield.

“Giving
Billions Isn’t Easy,” also by Karl Taro Greenfield.

“Venture
Philanthropists,” by Karl Taro Greenfield and David S. Jackson.

“He Gives Best by Investing,” an unsigned story about the philanthropic
interests of Larry Ellison, founder of the Oracle software company and
described here as “the richest man in the world,” at least at the time the
article appeared.

“The Gift of Literacy,” by Anamarie Wilson.

Plus
several sidebar features describing individual giving profiles of new
technology millionaires and others.

PLANNERS’
FORUM

Trustee
Duties Under the Prudent Investor Rule

By Thomas W. Cullinan, J.D., Omaha,
Nebraska

Our guest editor this month is Tom Cullinan of Omaha, Nebraska. Tom holds degrees in business and law and has 15 years of
professional experience in institutional financial services and planned giving
program management. His volunteer work includes the advisory board of the
National Planned Giving Institute at The College of William and Mary and board of Charitable Accord. We express
our appreciation to Tom for contributing this important article to CGPNews.

This article is a review of the obligations of
trusteeship and a general outline of the Prudent Investor Rule as it affects
charitable trusts. It seeks to remind us about the fiduciary duties and
potential liabilities facing the trustee of a charitable trust, and also
highlights questions for any such trustee (including a charitable organization
that chooses to serve as trustee), the board member of a not-for-profit
institution, and the gift planning practitioner. Some readers may find this
discussion relates to stewardship issues, other types of life income gifts, and
current business practices for both commercial trustees and not-for-profit
trustees.

Background
of Trust Administration and Investment of Trust Funds

The origins of trust investment law were derived 170
years ago (then 21-year-old Abraham Lincoln was clearing and fencing his
father’s farmland in Illinois) in the written opinion for the case of HarvardCollege v. Amory that defined the “prudent man rule.”
Trustees in general would be held “to observe how men of prudence, discretion
and intelligence manage their own affairs, not in regard to speculation, but in
regard to the permanent disposition of their funds, considering their probable
income, as well as the probable safety of the capital to be invested.”

Over intervening years — as cases with various fact
patterns and interpretations have been tried, analyzed, and offered as
precedent — the generality of the rule became encumbered and less adaptable. In
many jurisdictions the rule morphed into “legal lists” of the investments the
prudent man could hold until the Restatement, Second, of Trusts § 227 (1959)
provided less restrictive guidance. Ever narrowing standards over the next 30
years, again derived by case law interpretations, led to the dual problem of
unrealistic standards and the increased probability that even the exercise of
care, skill, and caution by a trustee might not be defensible.

The evolution of modern investment practices and
portfolio theory during the decades of the late 20th century caused broad revisions in trust investment
management. Due to these changes it became necessary to define operational
parameters that any trustee might apply with confidence that would satisfy his
or her fiduciary responsibilities. So it is that the Prudent Investor Rule was
revised again to permit a trustee to follow generally agreed theories and
principles in the administration and investment of trust funds.

The
Standards

Following are the fundamental, current requirements of
the Prudent Investor Rule for both a private trustee and trustee of a
charitable trust.

§ 227. General Standard of Prudent Investment

The
trustee is under a duty to the beneficiaries to invest and manage the funds of
the trust as a prudent investor would, in light of the purposes, terms,
distribution requirements, and other circumstances of the trust.

(a)This
standard requires the exercise of reasonable care, skill, and caution, and is
to be applied to investments not in isolation but in the context of the trust
portfolio and as a part of the overall investment strategy, which should
incorporate risk and return objectives reasonably suitable to the trust.

(b)In making and
implementing investment decisions, the trustee has a duty to diversify the
investments of the trust unless, under the circumstances, it is prudent not to
do so.

(2)act with
prudence in deciding whether and how to delegate authority and in the selection
and supervision of agents (§ 171); and

(3)incur only
costs that are reasonable in amount and appropriate to the investment
responsibilities of the trusteeship (§ 188).

(d)The trustee’s
duties under this Section are subject to the rule of § 228, dealing primarily
with contrary investment provisions of a trust or statute.

§ 389. Investments of Charitable Trusts

In
making decisions and taking actions with respect to the investment of trust
funds, the trustee of a charitable trust is under a duty similar to that of the
trustee of a private trust.

Not
only has the Prudent Investor Rule become the law in most states, it has also
been broadly adapted to other public funds, pension reserves, and other assets.
However, the commentary following these two Restatement sections cautions
trustees and practitioners that statute and/or case law in some jurisdictions
restrict the trustee’s investment authority. In addition, it is important to
note that the general standard can be modified if the terms of the trust
contain a provision to the contrary, or if an opposing statutory provision (or
judicial interpretation of an applicable statute) exists.

The Prudent Investor Rule in Section 228, which
governs investment by trustees, clearly requires the trustee to conform with
conflicting statutory provisions. That section further states that while
holding the trust powers granted by virtue of the trust, the trustee has a duty
to all beneficiaries to conform to the terms of the trust when directing or
restricting investments by the trustee. Comment b on the basic duties of
the Prudent Investor states that the terms of the trust may be “ . . . express
and implied, may be derived from written or spoken words, circumstances
surrounding the establishment of the trust, and sometimes statutory language
that is automatically imported into trusts or by which some trusts are
established.”

Additionally,
the trustee must adhere to basic fiduciary standards relating to making, monitoring,
and reviewing investments. Though the trustee is not held to guarantee
investment performance, when things go wrong a breach of trust can be found by
examining the prudence of a trustee’s conduct.

Selected
Duties of the Trustee

Loyalty.
Each trustee is bound to administer the trust in a manner that is only in the
interest of the beneficiaries. Generally, the trustee may neither compete with
nor profit at the expense of a beneficiary. It follows that, absent terms of
the trust permitting such actions (though never in bad faith), a trustee may
not sell trust property to himself individually (or vice versa) or have a
personal interest in a transaction that may affect his judgement.

In the case of a corporate
trustee, the sale of trust property to an officer, director, or one of its
departments is a clear violation of fiduciary duty.

It is improper to invest trust
assets in the trustee’s business, and it is improper for the trustee to borrow
money or lease property held in the trust.

The trustee’s duties run to
the beneficiaries only and not to the benefit of a third party or for interests
outside of the purposes of the trust.

Impartiality.
Whether their interests are concurrent or successive, according to the
Restatement comment, a trustee must deal fairly and impartially whenever there
are two or more beneficiaries of the trust. Though the trust language may grant
discretion in favoring a beneficiary, the court can prevent abuse of that
discretion.

Unless the trust directs
otherwise, a trustee has a duty to invest in a manner that will provide
reasonable total return and protect the value of its property.

The safety of capital concept
includes preventing the erosion of purchasing power due to inflation.

When there are two or more
life beneficiaries the trustee has the duty to consider the individual tax
circumstances of each while maintaining fidelity to the principal.

Delegation. Despite
the duty that a trustee must personally administer the trust, the trustee may
delegate one or more of the responsibilities of trusteeship when it is prudent
to do so. Having the discretion to delegate also means that there can be an
imprudent decision to delegate and an imprudent failure to delegate. Further,
whether the trustee exercised care, skill and caution in the process of
delegation turns on agent compensation, terms and length of the arrangement,
and how agents were monitored and supervised.

A trustee’s delegation of
responsibilities is a matter of fiduciary discretion.

Unless permitted by the terms
of the trust, a trustee may not permanently transfer the entire administration
of a trust to another person, co-trustee, or agent.

A person named trustee may
disclaim the appointment, but once he or she accepts the trusteeship may not
resign or transfer trust property to a substitute trustee unless by court order
or under the terms of the trust.

The trustee may seek and
accept advice from others (notably accountants, attorneys, and financial
specialists) provided that such advice involves reasonable expense that is
necessary and appropriate.

Stewardship is a general duty
of the trustee, as beneficiaries are entitled to be furnished information about
the trust and to be consulted by the trustee on an impartial basis regarding
administrative matters and the beneficiary’s preferences and circumstances.

When professional investment
advice is required, the trustee must at minimum establish the investment
objectives and direct the investment strategy.

Productivity.
Trustees must manage trust property
in a productive manner consistent with the fiduciary duties of caution and
impartiality. The objective is total return and a balancing of the competing
interests of income and principal consistent with the purposes, requirements,
and circumstances of the trust. It is recognized that attaining income and
corpus goals (especially the latter) is uncertain in any given period of time.

If land is in the trust the
trustee is to manage the trust assets in a way that will produce trust
accounting income (though this is done with regard to returns generated by the
entire trust and not any particular asset).

When the trustee is to
transfer possession of real estate to a beneficiary the trustee’s duty may be
directed less toward productivity in favor of preserving the property.

A trustee’s duty with regard
to tangible personal property is to sell or lease the assets unless suitable
for investment.

A trustee will likely be
liable for a failure to invest cash held for an unreasonably long time, though
a reasonable balance in a checking account to secure appropriate banking
services may itself be considered sufficient return.

When wasting assets are in the
trust the trustee owes a duty to the principal beneficiary to either sell the
depleting assets or use accounting or other practices that protect the corpus.

Selected
Trustee Liabilities

Breach
of trust. A trustee committing a
breach of trust will be accountable for profit to the trust that did not accrue
to the trust due to the breach, and must restore the values to the trust estate
and distributions to the levels that would have existed had there been no
breach. The beneficiaries may affirm a transaction resulting in a breach of
trust, essentially accepting the trustee’s improper conduct. In this event the
trustee is obligated to compensate the trust for a loss (which is defined to
include a failure to realize income, capital gain, or appreciation that would
have resulted from proper administration).

The trustee is not liable for
losses that occur when the trustee exercises reasonable care and skill and does
not commit a breach of trust.

A trustee who commits a breach
of trust is not subsequently relieved of the duty to properly administer the
trust.

Removal from office and denial
of fees are among the court’s remedies for misconduct.

Loyalty.
If a trustee sells trust property to
himself at a favorable price, a beneficiary has three remedies. He can force
the trustee to pay the difference to the trust, or cancel the sale with a
transfer back to the trust along with any lost income, or resell and pay any
excess amount over to the trust. If a trustee sells his trust property to the
trust at an above-market price, a beneficiary can force the trustee to repay
the difference, or cancel the purchase and repay the price. If the property
sold loses value, the trustee may be charged for the loss, and if the property
increases in value the trustee is chargeable for any profit from the
transaction.

When a trustee violates a duty
to a beneficiary and is compensated by a third party (including commissions or
bonus) for actions done related to the administration of the trust, that
trustee is accountable for the amounts paid as compensation.

Unless authorized by the trust
terms, a bank or corporate trustee purchasing its own stock for the trust
commits an improper purchase (even if the purchase ofshares issued by a
similar institution would be a suitable investment, or if the shares are
purchased from a third party).

Improper
investments. When the trustee fails
in his duty not to purchase certain property the beneficiaries may elect to
reject or affirm the purchase. When they reject the purchase the trustee
replaces the purchase price, plus an adjustment for a reasonable total return
for appropriately invested assets. Until the trustee has restored the value to
the trust, the beneficiaries’ claim is secured by a lien against the property
purchased improperly.

When a trustee fails to make a
proper investment within a reasonable time, the beneficiaries are, as much as
possible, to be restored to the position they would have enjoyed if the trustee
had not committed the breach.

If the trustee is in breach of
trust due to a failure to invest a specified sum in designated securities, the
beneficiaries can compel the purchase and force the trustee to make up any
increased purchase price and make good on any lost income from the trustee’s
own resources.

Duties
Regarding Charitable Trusts

Though the duties of the trustee of a charitable trust
are substantially the same as those for a private trust, they are generally
enforceable by the Attorney General. Where the management of a charitable trust
involves multiple trustees, a majority of the trustees may act unless the terms
of the trust specify otherwise.

Comment
a to Section 389 sets out the general investment duties for the trustee.
“The charitable trustee has a “duty to the beneficiaries to invest the funds of
the trust as a prudent investor would, in light of the purposes, terms,
obligations, and other circumstances of the trust,” absent contrary statute or
trust provision. “This standard requires the exercise of reasonable care,
skill, and caution, and is to be applied to investments not in isolation but in
the context of the trust portfolio and as part of an overall investment
strategy . . . . Thus, in deciding whether to purchase, retain, or dispose of
investments and in implementing investment decisions, the trustee has the
authority and is subject to the standards provided by the prudent investor
rule.”

Further,
funds invested by charitable corporations for general purposes are also subject
to the prudent investor rule.

Charities
Serving as Trustee

The decision by a not-for-profit organization to serve
as trustee of a charitable trust is critical on several levels. Viewed by the
prospective donor it may be seen as an accommodation or facilitation of an
important gift. The charity’s board and executives will see the potential for
increased liability (if things go wrong) and the potential for increased giving
(if things go right).

Gifts made to charitable organizations are, by
definition and common law practice, gifts “in trust” because the assets must be
used in furtherance of the charitable purposes. Donors frequently make their
gifts to charity restricted to specific purposes, or through trusts
administered by the charity in perpetuity (as with endowments) to fulfill the
donor’s charitable intent. Many charities elect to serve as trustee in split
interest trusts provided that service furthers its charitable purposes (such as
building capital and/or endowment).

Charities that serve as trustee do not make a profit
through that service. Typically, they reimburse themselves for the costs
incurred in administering those trusts and these costs may be lower than the
fees charged by commercial trustees. They perform these duties primarily to
maintain a close relationship to their donors, and they understand that the
obligations of trusteeship to support loyalty and good stewardship. It is also
common for charities to administer trusts that are smaller (and therefore
considered unprofitable) than those administered by commercial trustees.

For some individual trustees, one might guess that
good investment performance has covered fiduciary mistakes. Broad investment
gains in recent years have led to high expectations among donors and income
beneficiaries, yet extending this era of unbroken double-digit returns year
after year is historically improbable.It is also possible that improper administrative or investment practices
in the management of charitable trusts may not withstand challenge if stock and
bond investments delivered flat or negative total returns for a year or more.
Charitable trustees need to be prepared to respond to their beneficiaries and
donors when that time comes.

Context
and Conclusions

While the gift planning practitioner and trustee may
rely on the Prudent Investor Rule as legal authority (the Restatement of the
Law Third was adopted in whole or in part during the 1990s in most states) it
was also specifically promulgated to be a guide. Readers of this article are,
as always, strongly encouraged to seek the advice of a professional qualified
in the specialized field of charitable gift and estate planning. Overlapping
statutes relating to charitable organizations (such as not-for-profit
corporation statutes, the Uniform Management of Institutional Funds Act, the
Uniform Principal and Income Act, Federal Reserve Board regulations, federal
private foundation laws, and other provisions especially in those states that
have not adopted the Prudent Investor Rule) require analysis beyond the scope
of this article.

Though we live today in what some term a litigious
society, a discussion of case law relating to these issues is also beyond the
scope of this article. In fact, as stated in the Foreword of the Rest. 3rd, Trusts (Prudent Investor Rule), the Director of the
American Law Institute suggests that case law requires separate consideration.
“It is to be recognized that trust law is most often applied in daily trust
practice, as distinct from litigation concerning trust administration,” he
wrote, though the Restatement itself includes citations for over 130 cases.

Before
assuming important fiduciary responsibilities that accompany serving as trustee
— the highest standards imposed by law — the board and executives of any
not-for-profit organization needs to carefully examine the risks and rewards of
that decision. The Prudent Investor Rule gives legal authority to assess
investment and administrative tasks, engage experts, and even delegate
responsibilities when appropriate to properly manage its duties under the
trust.

This publication is designed to provide accurate
authoritative information in regard to the subject matter covered.It is sold with the understanding that the
publisher is not engaged in rendering legal, accounting, or other professional
service.If legal advice or other expert
assistance is required, the services of a competent professional should be
sought.From a Declaration of Principles jointly adopted by a
Committee of the American Bar Association and a Committee of Publishers.

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